Australia’s gas ambitions face major hurdles

VirginiaHarrison

Reuters

A sign at a Santos gas well, west of Brisbane, Australia.

SYDNEY (MarketWatch) — Australia has big ambitions when it comes to gas — whether liquefied natural gas or coal-seam gas — but analysts are warning of cost blowouts and delays across a multi-billion-dollar array of projects, as labor pressures and environmental backlash intensify.

The resource-rich nation is pushing to become the world’s second-largest liquefied natural gas (LNG) exporter, and has invested more than $140 billion dollars into the sector since 2007.

Along with major energy consumer China and India, demand for LNG from Southeast Asia is also expected to surge. Growing resistance to nuclear power in the wake of Japan’s Fukushima Daiichi disaster adds further upside to the sector.

But there are concerns Australia has bitten off more than it can chew.

“The reality is the LNG world is looking at Australia and thinking: My God, what is going on in there?” said Andrew Blakely, oil and gas analyst at Perpetual in Sydney.

“How can you possibly be developing six or seven LNG projects at the same time, given you developed one, over the last five years,” he said.

Earlier this year, Australia’s largest listed oil and gas company, Woodside Petroleum Ltd. (WPL)
WOPEY, +1.71%
announced a six-month delay and 900 million Australian dollar ($898.4 million) cost increase on its flagship Pluto LNG project. It was the third major cost overrun for the project.

Among the pressing problems is a national skills shortage that threatens to push costs up and timelines back, particularly with seven other major LNG projects finalized in Australia, and a string of others planned.

“There are so many projects going on at the moment, with a clear shortage of people to work on them,” said senior investment manager at Aberdeen Asset Management Andrew Preston.

“If Australia can’t bring in people to fill those gaps, quickly and efficiently, then the costs will rise. We’re seeing this happening in a lot of projects, not just Woodside,” he said.

Citing a the massive Gorgon project, led by Chevron Corp.
CVX, -0.40%
Preston said there was “a huge contingency factor in its estimates, much more than you would expect.”

Bechtel Corp., an engineering and construction company developing three LNG plants at Gladstone in Australia’s Queensland state, recently announced it will hire 400 adult apprentices for work on the sites.

But that injection won’t be enough to ease labor tightness in the booming region.

“They’re going to struggle to deliver three projects at the same time in Gladstone,” Perpetual’s Blakely said. “Australia has unique challenges in terms of its ability to deliver these projects.”

Environmental risk

LNG projects aren’t the only ones facing problems: This month, oil and gas firm Santos Ltd. (STO)
SANZ
halted drilling at a coal-seam gas site in the state of New South Wales in response to farmers’ concerns with the project, in a sign of rising hostility toward the growing industry.

Coal-seam gas (CSG) deposits are found underground and extracted by drilling wells, and then pumping in high-pressure water and chemicals to release the gas, leaving large amounts of waste water for disposal. Finally, the CSG deposits are converted to LNG for export.

The practice has drawn widespread public — and increasing political — opposition. The Australian government announced Monday it will establish a panel of scientific experts to advise on CSG projects. Read more on Australia's coal-seam gas panel.

Farmers and environmentalists are concerned about the long-term effects on agricultural land, as particularly the impact of CSG extraction on ground water.

“You have to process the water, which comes as a by-product of mining the gas,” Aberdeen’s Preston said. “You must dispose of large quantities of saline water, making it a very costly process.”

“There will potentially be some environmental issues which may hold up the approvals for projects going forward. That could add to the costs of the CSG-to-LNG projects,” he said.

Stocks to watch

Despite the challenges, analysts do see value in some of Australia’s energy sector.

Perpetual’s Andrew Blakely names Oil Search Ltd. (OSH)
OISHY, +0.72%
his “top domestic pick.” Focused on Papua New Guinea, the company is the archipelago nation’s largest oil and gas producer, and also holds a 29% interest in the $15 billion Papuan LNG project, operated by Exxon Mobil Corp.
XOM, -0.11%

“Some would argue its Papua New Guinea, so there’s political risk, but you’ve been seeing oil and gas exports out of PNG for decades,” Blakely said.

“But its exposure to the [Papuan] LNG project … clearly has superior returns to almost any other greenfield LNG project in Australia,” he said. “If you’re investing in a long-life, low-cost, expandable asset that’s exporting into the export-pricing market, then you are setting yourself up for success over the longer term.”

Given its international investment mandate, Perpetual’s Global Resources Fund has limited exposure to Australian energy stocks, and Blakely said “a lot of the international stocks tend to price cheaper than Australian stock — a Chevron over a Woodside, for example.”

However, Woodside remains Aberdeen Asset Management’s only Australian energy exposure.

“It’s the company in the sector that has proven it can deliver the goods, even though its had a few difficulties,” investment manager Preston said.

“The one [issue] that gives us most concern is the viability of having enough gas at Pluto 2. … You can’t achieve the economies of scale if you stop at one train,” he said.

As for CSG, Preston said these projects tend to be more capital-intensive than straight-LNG facilities.

“The calorific value of the West Australian [LNG] assets is higher than of the east coast CSG assets,” he said. “Once the LNG projects begin to flow, the profitability is higher because it’s a much simpler process to take off the gas, and to ship it abroad.”

“The company needs to put down a whole lot more wells to extract CSG, whereas you need one or two crackers to get a good flow of LNG,” Preston said.

Perpetual’s Blakely said CSG investors should also be prepared for a longer hold.

“In terms of return on investment capital, particularly for some of the CSG-to-LNG projects, the early phases of those projects are going to be pretty thin returns,” he said. “CSG are at the lower end of the margin-return spectrum.”

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